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A win-win solution for the bullwhip problem


Robert N. Bouteab; Stephen M. Disneyc; Marc R. Lambrechtb; Benny Van Houdtd
a
Operations & Technology Management Center, Vlerick Leuven Gent Management School, Leuven,
Belgium b Research Center for Operations Management, Katholieke Universiteit Leuven, Leuven,
Belgium c Logistics Systems Dynamics Group, Cardiff Business School, Cardiff University, Cardiff, UK
d
Department of Mathematics and Computer Science, University of Antwerp, Antwerpen, Belgium

To cite this Article Boute, Robert N. , Disney, Stephen M. , Lambrecht, Marc R. and Van Houdt, Benny(2008) 'A win-win
solution for the bullwhip problem', Production Planning & Control, 19: 7, 702 — 711
To link to this Article: DOI: 10.1080/09537280802573767
URL: http://dx.doi.org/10.1080/09537280802573767

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Production Planning & Control
Vol. 19, No. 7, October 2008, 702–711

A win–win solution for the bullwhip problem


Robert N. Bouteab*, Stephen M. Disneyc, Marc R. Lambrechtb and Benny Van Houdtd
a
Operations & Technology Management Center, Vlerick Leuven Gent Management School, Leuven, Belgium;
b
Research Center for Operations Management, Katholieke Universiteit Leuven, Leuven, Belgium; cLogistics Systems
Dynamics Group, Cardiff Business School, Cardiff University, Cardiff, UK; dDepartment of Mathematics and
Computer Science, University of Antwerp, Antwerpen, Belgium
(Received 29 August 2008; final version received 10 October 2008)

An important supply chain research problem is the bullwhip effect where demand variability increases as one
moves up the supply chain. This distorted information may lead to inefficiencies. In this article we suggest
a remedy to reduce the bullwhip effect. We focus on an inventory replenishment rule that reduces the variability
of upstream orders and generates a smooth order pattern. However, dampening the order variability has
a negative impact on customer service due to an increased inventory variance. We resolve this conflicting issue by
taking the impact of the replenishment rule on lead times into account. A smooth order pattern generates shorter
and less variable (production/replenishment) lead times, introducing a compensating effect on the inventory
levels. We show that by including endogenous lead times in our analysis, the order pattern can be smoothed to
a considerable extent without increasing stock levels, resulting in a win–win solution for both supply chain
echelons. Finally we discuss several order smoothing approaches from an industrial perspective and comment on
Downloaded At: 23:35 1 September 2010

how our results may influence these cases.


Keywords: supply chain control; supply chain collaboration; bullwhip effect

1. Introduction: the bullwhip problem executive seminars. Simchi-Levi et al. (1998) developed
A major cause of supply chain deficiencies is the a computerised version of the Beer Game, and several
bullwhip problem, which refers to the tendency of versions of the Beer Game are nowadays available,
replenishment orders to increase in variability as they ranging from manual to computerised and even web-
move up a supply chain. Jay Forrester (1961) was based versions (e.g. Chen and Samroengraja 2000,
Jacobs 2000).
among the first researchers to describe this phenom-
This bullwhip effect throughout the supply chain
enon, then called ‘demand amplification’. Procter &
can lead to tremendous inefficiencies: excessive inven-
Gamble first coined the phrase bullwhip effect to
tory investment, poor customer service, lost revenues,
describe the ordering behaviour witnessed between misguided capacity plans, ineffective transportation,
customers and suppliers of Pampers diapers. While and missed production schedules (Lee et al. 1997a).
diapers enjoy a fairly constant consumption rate, P&G Lee et al. (1997b) identify five major operational causes
found that wholesale orders tended to fluctuate of the bullwhip effect: the use of ‘demand signal
considerably over time. They observed further ampli- processing’, non-zero lead times, order batching,
fication of the oscillations of orders placed to their supply shortages, and price fluctuations. Our focus is
suppliers of raw material. on the issue of demand signal processing, which refers
A number of researchers designed games to to the practice of adjusting the parameters of the
illustrate the bullwhip effect. The most famous game inventory replenishment rule. These rational adjust-
is the ‘Beer Distribution Game’. This game has a rich ments may cause over-reactions to short-term fluctua-
history: growing out of the industrial dynamics work tions and lead to variance amplification. In other
of Forrester and others at MIT, it was later developed words, the replenishment rule used by the members of
by Sterman in 1989. The Beer Game is by far the most the chain may be a contributory factor to the bullwhip
popular simulation and the most widely used game in effect. Following the same line of argument it can be
many business schools, supply chain electives and seen that the replenishment policy can also be used to

*Corresponding author. Email: robert.boute@vlerick.be

ISSN 0953–7287 print/ISSN 1366–5871 online


ß 2008 Taylor & Francis
DOI: 10.1080/09537280802573767
http://www.informaworld.com
Production Planning & Control 703

reduce or tame the bullwhip effect. This is exactly what


we aim to do in this contribution.
The remainder of the article is organised as follows.
In the next section we describe our model and
introduce notation. In Section 3 we propose
a replenishment policy that is able to dampen the
order variability. This reduces the bullwhip effect in an
effective manner. However, as will be explained in Figure 1. A two echelon supply chain modelled as
Section 3, dampening the order variability may have a production/inventory system.
a negative impact on customer service. We do find
a win–win solution when we include the impact of the
replenishment rule on the manufacturer’s lead times. replenishment lead time, denoted by Tp. A schematic of
This is done in Section 4 where we show that a smooth our model is shown in Figure 1.
order pattern generates shorter and less variable
(production/replenishment) lead times, introducing
a compensating effect on the safety stock. Section 5 3. Taming the bullwhip: order smoothing
numerically illustrates our findings. In Section 6 we Due to the bullwhip effect, the retailer’s orders Ot to
discuss other techniques to reduce order variability and the manufacturer tend to have a larger variance than
illustrate with a practical application in industry. the consumer demand Dt that triggers the orders. This
Section 7 concludes. order variability can have large upstream cost reper-
cussions. The upstream manufacturer aims to smooth
production and therefore he prefers minimal variability
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2. Model description in the replenishment orders from the (downstream)


We consider a two echelon supply chain with a single retailer. The manufacturer not only prefers a level
retailer and a single manufacturer. Every period, the production schedule, the smoothed demand also allows
retailer observes customer demand, denoted by Dt, him to minimise his raw materials inventory cost.
representing a finite number of items that customers Balakrishnan et al. (2004) emphasise the opportunities
buy from the retailer. We assume that customer to reduce supply chain costs by dampening order
demand Dt is identically and independently distributed variability.
(i.i.d.) over time. If there is enough on-hand inventory This has led to the creation of new replenishment
available, the demand is immediately satisfied. If not, rules that are able to generate smooth order patterns,
the shortage is backlogged. which we call ‘smoothing replenishment rules’.
To maintain an appropriate amount of inventory Smoothing is a well-known method to reduce varia-
on hand, the retailer places a replenishment order with bility. A number of production level smoothing rules
the manufacturer at the end of every period. The order were developed in the 1950s and 1960s (e.g. Simon 1952,
quantity Ot is determined by the retailer’s replenish- Magee 1958). The more recent work on smoothing
ment policy. We assume that the manufacturer does replenishment rules can be found in Dejonckheere et al.
not hold a finished goods inventory, but instead (2003) and Balakrishnan et al. (2004).
produces on a make-to-order basis. The replenishment
orders of size Ot enter the production facility where
they are processed on a first-come-first-served basis. 3.1. A smoothing replenishment policy
Orders that arrive at a busy production facility must Given the common practice in retailing to replenish
wait in a queue. We assume that the production times inventories frequently (e.g. daily) and the tendency of
for a single product are i.i.d. random variables and to manufacturers to produce to demand, we will focus
ensure stability (of the queue), we assume that the our analysis on periodic review, base-stock or order-
utilisation of the production facility (average batch up-to replenishment policies. The standard periodic
production time divided by average batch inter-arrival review base-stock replenishment policy is the (R, S )
time) is strictly smaller than one. replenishment policy (Silver et al. 1998). At the end of
Once the complete batch (equal to the replenish- every review period R, the retailer tracks his inventory
ment order) is produced, it is immediately sent to the position IPt, which is the sum of the inventory on
retailer. The time from the moment the order arrives at hand (items immediately available to meet demand)
the production system to the point that the production and the inventory on order (items ordered but not
of the entire batch is finished is the production or yet arrived due to the lead time) minus the backlog
704 R.N. Boute et al.

(demand that could not be fulfilled and still has to is commonly used as a measure for the bullwhip effect),
be delivered). A replenishment order is then placed which is in this case given by
to raise the inventory position to an order-up-to
VarðOÞ 
or base-stock level S, which determines the order ¼ : ð6Þ
VarðDÞ 2  
quantity Ot:
Hence, if  ¼ 1, these expressions reduce to the
Ot ¼ S  IPt : ð1Þ
standard base-stock policy, where Ot ¼ Dt; we chase
A smoothing replenishment policy is a policy where the sales and thus there is no variance amplification. For
decision maker does not recover the entire deficit 1 5  5 2 we create bullwhip, i.e. the order variance
between the base-stock level and the inventory position is amplified compared to the demand variance. This
in one time period (contrary to what happens in tendency is often observed in reality, or when playing
Equation (1)). Magee (1958) and Forrester (1961) the Beer Distribution Game (Dejonckheere et al. 2003).
propose to order only a fraction of the inventory For 0 5  5 1 we find that this replenishment
deficit, resulting in the following ordering policy (see rule generates a smooth replenishment pattern, i.e. it
also Warburton 2004): dampens the order variability. Under a fixed lead time
assumption such a smoothing policy is justified when
Ot ¼   ðS  IPt Þ: ð2Þ production (or ordering) and holding costs are convex
or when there is a cost of changing the level of
Forrester (1961) refers to 1/ as the ‘adjustment time’ production (Veinott 1966). When the production
and hence explicitly acknowledges that the deficit capacity is fixed and lead times result from a single
recovery should be spread out over time. server queueing system (as in the model described in
When customer demand is i.i.d., the base-stock this article), this replenishment rule enables to smooth
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level S is a fixed constant. Boute et al. (2007) show that the manufacturer’s production, resulting in shorter
Equation (2) gives rise to an autocorrelated order order-to-delivery times and more balanced, peak
pattern, given by shaving production schedules, which are beneficial
for the manufacturer. Besides the benefits realised
Ot ¼ ð1  Þ  Ot1 þ   Dt : ð3Þ through a smoother planning, the manufacturer also
realises cost savings on its own raw materials and/or
Hence, the retailer’s replenishment orders are not component inventories (Balakrishnan et al. 2004).
statistically independent, because from Equation (3)
we derive that the correlation between the orders is
equal to 3.2. Is smooth smart?
corrðOt , Otx Þ ¼ ð1  Þx : ð4Þ Since the bullwhip effect has a number of highly
undesirable cost implications, taming the bullwhip,
Moreover, Boute et al. (2007) demonstrate that the or dampening the order variability, seems to be
base-stock level S in Equation (2) is not only affected a dominating operations strategy. We have to be careful
by lead time demand, as in the standard base-stock not to focus only on one side of the production
policy, but it also contains an additional ‘smoothing’ smoothing ‘coin’ however. In developing a replenish-
component. More specifically, the base-stock level is ment rule one has to consider the impact on the
given by inventory variance as well. The manufacturer does
benefit from smooth production, but dampening
S ¼ SS þ ½EðTpÞ þ 1  EðDÞ þ ð1  Þ=  EðDÞ, ð5Þ variability in orders may have a negative impact on
the retailer’s customer service due to inventory variance
where SS denotes the safety stock and E(Tp) and E(D) increases (Bertrand 1986, Disney and Towill 2003).
represent respectively the average lead time and Disney et al. (2006) quantify the variance of the net
average demand. stock and compute the required safety stock as
It is notable that the replenishment rule described a function of the smoothing intensity. Their main
by Equation (3) is exactly the same as the exponential conclusion is that when customer demand is i.i.d.,
smoothing policy proposed by Balakrishnan et al. order smoothing comes at a price – in order to
(2004) to decrease order variability. To examine the guarantee the same fill rate, more investment in safety
variability in orders created by our smoothing rule, we stock is required. As a consequence, retailers, driven
look at the ratio of the variance of the orders over the by the goal of reducing inventory (holding and
variance of demand (in the literature this variance ratio shortage/backlog) costs, prefer to use replenishment
Production Planning & Control 705

policies that chase demand rather than dampen supply system. For this purpose we can and do apply
consumer demand variability. This leads to a tension the results of queueing theory’.
between the preferred order variability of retailers It is essential to extend pure inventory systems with
and manufacturers. exogenous lead times to production–inventory systems
However, we can model a two echelon supply with endogenous lead times. After all, inventory
chain as a production–inventory system, as illustrated influences production by initiating orders, and produc-
in Figure 1. This implies that a replenishment order tion influences inventory by completing and delivering
generated by the retailer’s inventory results in an those orders to inventory. In Figure 2 the interaction
arrival of a production order at the manufacturer. between the retailer’s replenishment policy and the
Hence the choice of the retailer’s replenishment manufacturer’s production system is illustrated: the
policy (amplifying or dampening customer demand replenishment orders constitute the arrival process at
variability in the replenishment orders) determines the manufacturer’s queue. The time until the order is
the arrival process of production orders at the produced (the sojourn time in the queueing system) is
manufacturer’s production queue and as such it affects the time to replenish the order. This replenishment lead
the distribution of the production lead times. time is a prime determinant in setting the safety stock
According to the laws of factory physics (Hopp and requirements for the retailer.
Spearman 2001), a smooth order pattern will give rise To estimate the lead time distribution we develop
to shorter and less variable lead times. This in turn a discrete time queueing model. By analysing the
exercises a downward effect on the retailer’s inventory characteristics of the replenishment orders, we impli-
level, which may compensate the increase in inventory citly analyse the characteristics of the production
variance. The quest for a win–win solution (smooth orders that arrive to the production system.
production and lower inventory levels) is the topic In a periodic review base-stock policy, the arrival
Downloaded At: 23:35 1 September 2010

of the next section. pattern consists of batch arrivals with a fixed inter-
arrival time (equal to the review period, R ¼ 1) and
with variable batch sizes. The supply system is bulk
4. In search of a win–win solution
queue, which tends to be difficult to analyse (Chaudry
4.1. Impact of order variance dampening on and Templeton 1983). Moreover as we can see from
lead times Equation (3), the batch sizes generated by our
Most inventory models proposed in the literature take smoothing rule are not i.i.d., rather they are auto-
the replenishment lead time Tp as a fixed constant or as correlated. Therefore the resulting queueing model is
an exogenous variable with a given probability substantially different from the M/M/1 make-to-stock
distribution (e.g. Kim et al. 2006). However, the queue, as considered by, for example, Karaesmen
replenishment orders do in fact load the production et al. (2004).
facilities. The nature of this loading process relative to The analysis of our queueing model can be solved
the available capacity and the variability it creates are using matrix analytic methods (Neuts 1981, Latouche
the primary determinants of lead times in the produc- and Ramaswami 1999). These methods are popular as
tion facility. Therefore the inventory control system modelling tools because they can be used to construct
should work with a lead time which is a good estimate and analyse a wide class of stochastic models. They are
of the real lead time, depending on the production applied in several areas, of which the performance
load, the interarrival rate of orders, and the variability analysis of telecommunication systems is one of the
of the production system (Hopp and Spearman 2001). most notable (Latouche and Ramaswami 1999).
Zipkin (2000, p. 246) states: ‘to understand the In a separate paper, the authors of this article discuss
overall inventory system, we need to understand the the solution procedure of this queueing model

Manufacturer’s
Retailer’s Order quantity queueing system
Inventory
control
Sojourn time in queueing system
Safety stock = replenishment lead time

Figure 2. Interaction between retailer’s inventory system and manufacturer’s production system.
706 R.N. Boute et al.

(Boute et al. 2007). The results confirm our expectation the number of shortages when a stock-out occurs.
that a smooth order pattern generates shorter and less Therefore we observe the system at the end of every
variable lead times. period t, after customer demand Dt is satisfied and
after replenishment order Ot has been placed with the
manufacturer. At that time there may be k  0 orders
4.2. Resulting impact on customer service and waiting in the production queue and there is always
safety stock one order in service (since the observation moment is
When demand is probabilistic, there is a definite immediately after an order placement) which is placed
chance of not being able to satisfy some of the k periods ago (Otk). Although k is a function of t, we
demand directly from stock. Therefore, a buffer or write k [as opposed to k(t)] to simplify the notation.
safety stock is required to meet unexpected fluctuations The inventory on hand or net stock NSt is then
in demand. The goal is to reduce inventory without equal to the initial inventory on hand plus all
diminishing the level of service provided to customers. replenishment orders received so far minus total
When the retailer faces (and satisfies) a variable observed customer demand. At the end of period t,
customer demand, but replenishes through a smooth the order Otk is in service, and the orders placed more
order pattern, more safety stock is required to buffer than k periods ago, i.e., Oti, i  k þ 1, are already
the difference between usage and supply. A reduction delivered in inventory, while customer demand is
of order variations comes with the cost of an increase satisfied up to the current period t. Assuming the
in inventory variability (Bertrand 1986). initial inventory level is equal to the base stock level S,
When lead times are endogenously determined, the net stock after satisfying demand in period t is
however, dampening variability in orders affects the equal to
replenishment lead time distribution as well. A smooth X X
Downloaded At: 23:35 1 September 2010

t1 t1
order pattern generates shorter and less variable lead NSt ¼ S þ Oti  Dti : ð8Þ
times, introducing a compensating effect on the i¼kþ1 i¼0
required safety stock. The aim is to find values for Substituting (3) into (8), we obtain
the smoothing parameter 0 5  5 1 where the decrease
in lead times compensates the increase in inventory X
k1 X
t

variance. In that case we can smooth production NSt ¼ S  Dti  ð1  Þik Dti : ð9Þ
i¼0 i¼k
without having to increase inventory levels to provide
the same customer service. Boute et al. (2007) evaluate the steady state distribu-
To do so, we characterise the inventory random tion of NSt. Some care must be taken when evaluat-
variable and use it to find the safety stock requirements ing (9), however, as the value of Dtk influences the age
for the system. Since the inventory is controlled by k of the order in service: the larger the demand size, the
stochastic lead times, the inventory is not necessarily larger the order size and consequently the longer it
replenished every period and we do not know exactly takes to produce the order. Moreover, since the order
when replenishment occurs. Moreover, the queueing quantity is also affected by previously realised custo-
analysis implies that it takes a longer time to produce mer demand, the demand terms Dti, i ¼ k þ 1, . . . , t
(and consequently replenish) a larger order quantity. also influence the order’s age k.
Hence the order quantity and its replenishment lead From the steady state distribution of the inventory
time are correlated, which has an impact on the variable NS, we can easily deduct the expected number
calculation of the inventory distribution. Therefore, of backorders E(NS), where NS ¼ max{0, NS},
if we want to determine the inventory distribution and the corresponding fill rate realised with a given
and the corresponding safety stock requirements in an base-stock level S. In practice, decision makers often
exact way, we need to take this correlation into account. determine the minimal base-stock level that is required
We measure customer service with the fill rate, to achieve a target fill rate. From this base-stock level
which is the proportion of the demand that can S, we then find the corresponding safety stock using
immediately be delivered from the inventory on hand Equation (5).
(Zipkin 2000)
expected number of backorders
Fill rate ¼ 1  : ð7Þ 4.3. The bullwhip effect results in a lose–lose
expected demand situation
To calculate the fill rate, we monitor the inventory on Note that the discussion above considers the situation
hand after customer demand is observed and we retain where we smooth the replenishment orders, which
Production Planning & Control 707

implies a replenishment parameter  smaller than one orders equal to demand and hence the variability in
in Equation (2). We may extend the analysis, however, demand is transmitted to the manufacturer. This policy
to the case where the replenishment parameter  is results in an average lead time of 0.67 periods and
larger than one, which implies an overreaction to the a variance of 0.44. The safety stock required to provide
inventory deficit. This policy is often observed in a 98% fill rate is equal to 36.95 units.
reality and leads to order variance amplification, or Suppose that the retailer chooses to smooth his
equivalently, induces the bullwhip effect. orders with a parameter  ¼ 0.4. This results in
When 1 5  5 2, the order pattern generated by an order pattern which is four times less variable
the replenishment policy (2) is negatively correlated [Var(O)/Var(D) ¼ 0.4/(2–0.4) ¼ 0.25]. When we main-
and it may generate negative order quantities. Since in tain the same lead time distribution, this smoothing
our model it is not possible to send negative orders to decision would lead to an increase in inventory
production, we have to preclude the possibility of variance, since inventory absorbs the variability in
negative orders. The following restriction on  given demand while the replenishments are relatively steady.
the minimum demand Dmin and the maximum demand As a consequence a higher safety stock has to be kept
Dmax ensures that Ot  1 (we refer to Boute (2006) for in order to maintain the same fill rate. This is clearly
a proof): a win–lose situation: the manufacturer can smooth
Dmin þ ð1  Þ  Dmax  2  : ð10Þ production, but at the expense of an increase in the
retailer’s inventory.
What is the impact of the bullwhip effect on the However, working with the same lead times is
performance in the supply chain? First of all, Disney incomplete. When the retailer smoothes his orders, he
et al. (2006) prove that the inventory variance increases sends a less variable pattern to the manufacturer. This
as we either smooth the order pattern ( 5 1) or inevitably results in a different lead time distribution.
Downloaded At: 23:35 1 September 2010

amplify the orders ( 4 1), compared to a pure chase Indeed, when we estimate the lead time distribution
sales policy where  ¼ 1. This increased inventory when we send a smooth order pattern with  ¼ 0.4 to
variability inflates the safety stock requirements at the manufacturer’s production, we observe a lower
the retailer. and less variable lead time distribution. The average
Moreover, this replenishment decision has an lead time decreases to 0.49 and its variance equals 0.36.
impact on the distribution of the lead times. More This in turn introduces a compensating effect on the
specifically, order variance amplification increases the required safety stock. We find that a safety stock of
variability at the production queue, which increases the 36.41 is sufficient to provide a 98% fill rate, which
lead times as a consequence. This leads to higher safety is slightly lower than when we do not smooth the
stocks. In other words, the bullwhip effect leads orders ( ¼ 1).
to an increased inventory variance, and additionally, In Figure 3 we show the effect of order smoothing
it generates longer lead times, reinforcing the inflated on the (average) lead times and safety stocks for
safety stock requirements. This is clearly a lose–lose a smoothing parameter  ¼ 0.2 to 1.3. As  decreases,
situation. the average lead times decrease as well (Figure 3a).
This is intuitively clear, as the order variability
decreases with a smaller , leading to a less variable
5. Numerical example arrival pattern at the queue and consequently decreas-
To illustrate our findings, we set up a numerical ing lead times. When we include this effect of order
experiment where a retailer observes an i.i.d. random smoothing on lead times, the safety stock becomes
daily demand of between 11 and 30 products with an a U-shaped function of the smoothing intensity.
average of 20.5 units per day and a coefficient of We can smooth the replenishment orders to some
variation of 0.135. The retailer satisfies this demand extent without having to increase the safety stock,
from his inventory on hand and replenishes with the whilst maintaining customer service at the same target
smoothing replenishment rule given by Equation (2). level. Moreover, we can even decrease our safety stock
We assume that the manufacturer’s production oper- when we smooth the order pattern (up to  ¼ 0.35).
ates 24 h per day and the production time of a single As such we may obtain a win–win situation for both
unit is geometrically distributed with an average of the retailer and the manufacturer. The manufacturer
64 min per unit. Hence the average production load is receives a less variable order pattern and the retailer
(20.5  64)/(24  60) ¼ 0.91. can decrease his safety stock while maintaining the
The retailer has to determine the parameter  to same fill rate. This Pareto-improving policy may
control his inventory. When  ¼ 1, the retailer places require contractual arrangements between the supply
708 R.N. Boute et al.

Figure 3. (a) Average lead times in function of the replenishment parameter . (b) Safety stock required to ensure a 98% fill rate
with endogenous lead times.

chain partners so that the lead time reduction is In a traditional supply chain, each level in the
effectively implemented (Tsay et al. 1999). supply chain issues production orders and replenishes
However, as of a certain point (around  ¼ 0.4) the stock without considering the situation at either up- or
safety stock increases sharply. When  approaches downstream tiers of the supply chain. This is how
Downloaded At: 23:35 1 September 2010

zero, the lead time reduction cannot compensate the most supply chains still operate, no formal collabora-
increase in inventory variability any more and the tion between the retailer and supplier. Collaboration
safety stock exceeds the safety stock that is required on the other hand can be installed through a wide
when the orders are not smoothed ( ¼ 1). range of concepts such as collaborative forecasting
When  4 1, we observe that lead times increase planning and replenishment (CPFR), information
further together with the safety stocks. Obviously, this sharing, vendor managed inventory (VMI,
is a lose–lose situation and needs to be avoided. including continuous replenishment). A more drastic
This numerical example well illustrates the solution can be obtained by a redesign of the supply
dynamics resulting from the retailer’s inventory deci- chain by eliminating echelons. Let us first focus
sion on the lead times and safety stocks. Obviously, the on VMI.
degree to which we should smooth and the exact Vendor managed inventory (VMI) eliminates one
amount of safety stock decrease depend on the decision point and merges the replenishment decision
observed demand pattern. with the production and materials planning of the
supplier. Here, the supplier takes charge of the
customer’s inventory replenishment on the operational
level, and uses this visibility in planning his own supply
6. Some practical examples of reducing order operations (e.g. more efficient production schedules
variability and transportation planning). With VMI, multi-
Order smoothing combined with endogenous lead echelon supply chains can act in the same way,
times may create a win–win situation for both the dynamically, as a single echelon of a supply chain.
retailer and the manufacturer. In order to effectively VMI often results in more frequent replenishments and
implement such a policy, the supply chain partners consequently the order quantity variance is reduced.
have to align their replenishment policies, i.e. the type Economies in transportation can be obtained through
of replenishment rule used and the setting of the ‘best’ an optimisation of the route planning and with
parameter value (). It is important to notice that such methods such as joint replenishment and inventory
a strategy goes far beyond ‘information sharing’. routing techniques. VMI is, in other words, an
In a practical setting, however, other coordination alternative to the smoothing replenishment policy
schemes may be used to achieve the same objective. We proposed in this article.
therefore briefly discuss a range of other order variance We discuss two cases to illustrate the benefits of
reduction tools and add real life examples where dampening the order variance. First, we analyse the
applicable. An excellent overview can be found in ordering pattern of a bakery company focusing on
Holweg et al. (2005). authentic specialities in the biscuit and cake
Production Planning & Control 709

world: caramelised biscuits, waffles, frangipane, and


cake specialities among others. For certain products,
a make-to-order policy is employed and the assump-
tions used in this article are largely satisfied. In 2002,

Shipments
the firm introduced a VMI programme implemented
in the SAP software, referred to as ‘customer replen-
ishment planning’ (CRP). In Figure 4 we show a graph
of the shipments from the production facility to the
distribution centre of a retailer (for one specific
product) in the pre-CRP period (2001–mid-2002) and
the shipments in the post-CRP period (mid-2002– PRE-CRP POST-CRP
2005). The coefficient of variation of the shipment Figure 4. The impact of VMI on the order variability for
quantities went down from 1.14 to 0.45 (a number a selected product.
observed for other products as well). We were also able
to collect (post-CRP) data on the shipments from the
distribution centre of the retailer to the different retail
outlets. For the specific product discussed above, we
obtain a coefficient of variation of 0.40. The company
now benefits from a higher flexibility in its production
planning and reduced its transportation costs
considerably. Moreover, inventories decreased,
improving the freshness of the products of the end
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consumer.
The second case deals with a more traditional
example of order smoothing of a UK grocery retailer.
Here we were asked to identify and reduce the cause
of workload variability in their own warehousing
(cross docking) and transportation activities. We
discovered that the replenishment algorithms that Figure 5. Smoothing in action in the UK grocery industry.
maintained stock levels at individual stores were the
source of a bullwhip effect. There were several
different replenishment algorithms in use, and we
times exist), then the retailer smoothing actions
were able to introduce a proportional controller into
will have a beneficial effect on the supplier finished
half of them. These modified algorithms controlled
goods. The retailer may still gain by this – the
65% of the sales volume, but only 35% of product
manufacturer may be more willing to accept on-going
lines. In general these were the higher volume
calls for cost reductions. This clearly illustrates
products. Figure 5 illustrates the performance of
the power of variance reduction techniques be it
the system with a ‘before’ and ‘after’ simulation of
a single product using real demand data for a single through VMI programmes or smoothing replenish-
product from a single store. The company had ment policies.
identified that this modification had allowed
a very significant reduction in contract staff in the
distribution centre and amount of third party logistics 7. Conclusions
costs to meet the peak demand on certain days The bullwhip problem has been studied by many
of the week. authors in recent years. Since the bullwhip effect has
In order to achieve this, the grocery retailer a number of highly undesirable cost implications,
had accepted a slight increase in the target safety taming the bullwhip is a dominating operations
stock in their stores. That is, they assumed exogenous strategy. Conventional bullwhip reduction is only
lead times. But, in effect, that is all they could one side of the coin, however. In developing
possibly do anyway, as they were ordering on day 1 a replenishment rule one has to consider the impact
for delivery in day 2. This meant that the suppliers had on the inventory variance as well. More specifically,
to keep a stock of finished goods. Thus if the suppliers dampening the variability in orders inflates the safety
maintained this stock with a production system stock requirements due to the increased variance of
that operated as a queue (that is endogenous lead the inventory levels. As a consequence, retailers, driven
710 R.N. Boute et al.

by the goal of reducing inventory (holding and Benny Van Houdt holds a MSc degree
in Mathematics and Computer
shortage/backlog) costs, prefer to use replenishment Science, and a PhD in Science from
policies that chase demand rather than dampen the University of Antwerp (Belgium).
consumer demand variability. Currently he is Assistant Professor at
We have shown that by treating the lead time the University of Antwerp. His main
as an endogenous variable, we can turn this research interest is the performance
evaluation and stochastic modelling of
conflicting situation into a win–win situation.
telecommunication networks.
A smooth order pattern gives rise to shorter and less
variable lead times. This introduces a compensating
effect on the retailer’s inventory level. In this
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